The Start-Up Equity Game

There’s an interesting thread over on Hacker News asking about employee (ie, non-founder) equity exits in the $500k-$1M range.

Something to note is that if you’re looking for a moderately big payout (let’s say $500k-$5M) in a few years from a start-up, being employee #5-25 is, in my view, not the right way to go.  Being employee #5-25 is for…  hmmm, let’s stick a pin in that and come back to it.

But the thing is, a startup that experiences a classic successful liquidity event will monetize for, these days, probably, between $2B and $20B.  If you get 0.03% of that, that’s $600k-$6M.  So that’s in the right range.  If your company monetizes for $1B, you get $300k, which is a nice consolation prize, or you can try for a slightly more generous equity package.

So my big point here is that you should be able to get 0.03% of a company as a late employee pre-liquidity.  You don’t need to be employee #5, or indeed employee #100, to get 0.03%.  If you’re looking for the moderately big payout, I think you’re far, far, far more likely to get it if you join a company relatively late, when it’s much clearer whether or not it’s going to be a success.  Also, your initial stock grant is much more meaningful if you join a company late — each funding round involves a very uncertain amount of stock dilution, so if there’s 0-1 funding rounds before liquidity, you have a much clearer idea of what your stock will actually be worth than if there’s 2-5 funding rounds before liquidity.

Of course, working for a big, already-successful company probably has the highest expected value overall.  If you can work for Google, you’ll get a lot of money.  But there are reasons why you might prefer a chance at a higher reward to a guarantee of a lower one, or you might just, like me, think that working at Google sounds like the seventh circle of Hell.  (This isn’t a knock at Google.  Working at any company that size sounds like the seventh circle of Hell).

So there’s a risk-reward knob that you can turn towards the chance (by no means the certainty) of getting $500k-$5M, and my point is that the way you turn towards that setting is by being employee #100-1,000 for a company that has already handled most of the hurdles towards liquidity.

But I think that start-up culture valorizes being employee #1, or #5, or #20.  Working on a really small team.  Indeed, I valorize that!  I’ve done it, and I think it’s a ton of fun.  But does it make sense?  Like, is there a risk/reward preference that is rewarded by being employee #5?

I’m…  not sure there is.  I think that that kind of early employee may be kind of a dip in the expected value graph.

Being a founder is for people who have a very high risk tolerance, but the reward is potentially $10M-$1B, with a couple of pretty nice consolation prizes in the low hundred thousands to low millions, but also perhaps more importantly a social consolation prize of potentially having connections with VCs and other founders that can get you a good position or an easier start if you want to be a founder again.

And let’s hypothesize that I’m right that for people with a medium risk tolerance, being employee #100-#1000 is the best way to have a chance at a $500K-$5M payout.

In between, you have employee #10, who may get 0.5% – 1.0% of the company.  What does that actually get him, in the event that the company experiences a liquidity event?

Well.  If he worked for the company for four years and then left it, and six years later the company succeeds, one pretty likely answer is that he gets $0.  Because, first of all, he probably had options and would have had to exercise them 6 years ago to keep any stock.  And at that point there were very real costs to doing so and only highly potential benefits.  So maybe he didn’t exercise.

But maybe he did exercise…  but how much of the company does he own?  He got say 0.75% of the company back when it had just had a series A, but the company has many more rounds of funding since then.  Some of them since he left the company.  Each one dilutes the business, and if you’ve left, you aren’t getting any follow-up grants that bring you back up to your original level (or beyond).  If the company did well, kind of textbook marched its way up through series D and then went public, maybe he still has a substantial share > 0.1%.  If the company went through a troubled spell, raised a down round, he might very well have less than the 0.03% we hypothesized for much later employees.

The early employee has all of these problems compared to a later employee:

1.  Much less certainty that his equity will ever be worth anything.

2.  Much longer to wait before any potential equity value.

3.  Much more potential dilution of his equity.

4.  Much more likely to be in the difficult decision of having to figure out whether to exercise for real costs now in return for a still highly uncertain future payout.

In return for, what, a x10 payout if everything goes perfectly?  A founder has a x100 payout (compared to the late employee) if everything goes perfectly, probably a better consolation prize than an early employee, and not a ton more uncertainty than the early employee.  Indeed, perhaps less!  A founder will have stock, not options, so if she ends up leaving her own company, she probably won’t face the vesting dilemma, and her amount of stock may be significant enough that she will receive a life-changing payout even if her shares are diluted x20 or more.

So I think you have to look for your consolation prizes as an early employee in other areas.  I’ve been that early employee in two companies recently.  In neither did my equity end up being worth anything.  But they really bulked up my resume, and got me the opportunity to work in in-demand areas and high-responsibility positions.  They were also really, really fun.

I don’t regret being an early employee.  But I would say that you need to be careful about what you’re getting into.

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